ECB's Draghi stands firm on stimulus as inflation ticks up

March 9, 2017 09:18 AM

The European Central Bank pledged on Thursday to keep its aggressive stimulus policy at least until the end of the year, arguing that inflation pressures in the Eurozone remained weak despite expectations of faster price growth

While expected, the decision showed the ECB's leadership was resisting calls from Germany to start winding down its 2.3 trillion euro ($2.43 trillion) bond-buying scheme, or at least signal its intention to do so, as growth and inflation rebound.

Instead, the Frankfurt-based central bank stuck to its plan of continuing the purchases until December. Crucially, it also pledged to keep interest rates at current, record-low levels until long after that, or even cut them if necessary.

"If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the program in terms of size and/or duration," the ECB said in a statement.

Justifying the stance at his regular news conference afterward, ECB President Mario Draghi presented upgrades in inflation expectations for this year and next but argued they did not alter the overall picture.

"There is no sign yet of a convincing upward trend on underlying inflation," he told reporters, adding that inflation -- which hit its target of almost 2 % last month -- was expected to rise "only gradually" in the medium term.

The ECB now sees headline inflation of 1.7 % this year compared to an earlier estimate of 1.3 %, and 1.6 % next year compared to a previous 1.5 % estimate. It saw prices rising an unchanged 1.7 % in 2019.

The ECB is scheduled to cut the pace of its bond purchases by a quarter from next month but continue them at least until year-end, or longer if it thinks inflation is below target.

But nearly a decade after the 19-country currency bloc's woes began, its economy is looking in better shape.

Economic sentiment is at a six-year high, trade is rebounding, services and manufacturing output are rising, and unemployment is at its lowest since 2009. Draghi accordingly announced small upgrades to eurozone growth forecasts, now seen at 1.8 % this year and 1.7 % next.

Germany's central bank governor Jens Weidmann and ECB director Yves Mersch have both made the case for ruling out further rate cuts.

German Finance Minister Wolfgang Schaeuble went further on Thursday, saying he was in favor of a "timely start to the exit" from the ECB's loose monetary policy, echoing calls from the German banking association and the Ifo economic institute.

That has left Draghi walking a tightrope, as improvements on the economic front are at risk of being derailed by hazards including the Dutch and French elections and global economic governance under new U.S. President Donald Trump.

Economists in a Reuters poll said the ECB's next move will be either a tweak of its guidance in the second half of this year or a gradual reduction in its asset-buying next year.

Among political risks on the horizon, the French election is likely to be a particular concern. With far-right candidate Marine Le Pen wanting to take France out of the Eurozone, markets are already bracing for a shock.

The cost of insuring French government debt against default has doubled since the start of the year while the yield differential between five-year French and safe-haven German bonds rose to its highest since 2013 last month.

Investor's nerves are affecting debt of periphery countries such as Italy and Portugal even though the ECB's main indicator of stress in the financial system is trending downwards.

About the Author